Daily Comment (September 10, 2020)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Equity markets were mostly flat to higher this morning, generally holding yesterday’s recovery. The ECB meets this morning; there was pre-meeting speculation that the ECB may try to weaken the EUR.  As we note below, this didn’t occur.  We lead off with Brexit. The Johnson government is facing a growing reaction to its plans to jettison its earlier agreement with the EU.  China news is next, followed by an update on the pandemic.  We discuss recent problems in North Korea.  Tech and business news close the report.  Due to the Labor Day holiday, the DOE energy data was delayed, so the Weekly Energy Update will be published tomorrow.  Here are the details:

ECB:  In initial comments, ECB President Lagarde said that there was no need to overreact to the EUR’s recent appreciation.  Given that, at least based on our valuation analysis, the EUR is still undervalued (fair value being just above $1.30), her position makes sense.  However, the EUR has appreciated on the news.

Brexit:  We continue to closely monitor trade negotiations between the EU and Westminster.  As we discussed yesterday, former members of the Johnson government viewed recent legislation being proposed by the U.K. as violating international law.  The FT editorial board questioned the wisdom of circumventing previously passed legislation.  Ireland, which would be at the frontier of the dispute, spoke out against the Johnson government’s proposals.  The EU is also expressing “concern.”  The Johnson administration is arguing that the PM didn’t fully understand what he was signing and thus should be able to rewrite it.  Although both sides are putting up a brave face, no trade arrangement would be hard on both sides.  Last year, 43% of U.K. exports went to the EU and 51% of U.K. imports came from the EU.  We still expect an arrangement to be struck at some point.  There is a growing chance that a hard Brexit may occur, which would be a bearish event for U.K. financial assets.  However, we doubt it would be very deep or long-lasting; in our experience, bad events that are well known in advance rarely cause lasting disruptions.  Thus, a drop in values may be an opportunity.

China news:

  • As the U.S. slowly removes itself from hegemony, we continue to monitor how other nations react. For example, in the eastern Mediterranean, France recently committed to supporting Greece against Turkey’s actions around Cyprus.  In Afghanistan, as the U.S. withdraws troops, China is increasing infrastructure investment in return for the Taliban and other groups cooperating to maintain order.  The U.S. experience would suggest that mere public investment alone won’t be enough, but it is notable that China is taking these steps.  Conditions in Afghanistan are deteriorating; the vice president narrowly escaped an assassination attempt.  Apparently, Beijing is worried about civil conflict disrupting the “road” part of the “one belt, one road” project.
  • The “visa wars” continue. Australia has revoked the visas of two Chinese scholars in retaliation to China’s harassment of Australian journalists.  The U.S. has cancelled over one thousand visas issued to Chinese nationals over security concerns.  The fallout from these actions remains unclear.  Australia is dependent on Chinese demand for its commodity products, although given the relative fungibility of such goods, commodity import restrictions don’t end up causing a loss of sales but an adjustment of trade flows.  If China doesn’t buy Australian iron ore, it will probably buy it from Brazil.  But the Brazilian customer who loses out to China will likely purchase the Australian iron ore China refused to buy.  The change isn’t costless; it increases inefficiency, at least at first, but it doesn’t mean the permanent loss of sales.
  • Brad Setzer, one of the best analysts on trade and investment flows, notes that despite the rhetoric the U.S. and China are falling into familiar patterns—China is oversaving and thus boosting exports and the U.S. is absorbing them. The basic problem isn’t really trade, it’s macroeconomic policy.  Tariffs don’t change those factors by themselves.  To fix the trade deficit, the U.S. needs to boost saving and China needs to increase spending.  Both actions would be disruptive, so they tend not to occur.
  • TikTok is trying to work out a plan to avoid selling its overseas operations.
  • Hong Kong stock exchanges are winning more listings of firms that have listed in the U.S. We suspect these are a backup in the event that the financial relationship with the U.S ruptures.  On a related note, despite a clear policy direction of reduced relations with China, financial firms continue to deepen their relations with Beijing.  Some of this is a divergence between the views of populists and establishment ideals.  For nearly four decades, U.S. firms have moved operations to China and U.S. policymakers have been mostly encouraging this action.  The policy appears to be changing but old habits die hard.
  • On a related note, Germany is struggling to respond to China’s human rights violations due to deep economic ties to Beijing. The economies have become so deeply entwined that it may be nearly impossible to break them absent of a kinetic war.
  • U. S. surveillance of Chinese naval exercises continues. China has been expanding these war games, and the U.S. is clearly interested in seeing what they are up to.  Needless to say, China would prefer to operate without observation.
  • Reports suggest that Chinese farmers are hoarding their wheat harvest, expecting higher prices because of recent flooding.

COVID-19:  The number of reported cases is 27,897,904 with 904,364 deaths and 18,797,729 recoveries.  In the U.S., there are 6,363,437 confirmed cases with 190,885 deaths and 2,387,479 recoveries.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high frequency data on various factors.  The Axios state map shows a continued downtrend in infections.


 North Korea:  As we noted earlier, the Hermit Kingdom was hit with two typhoons, Haishen and Maysak.  The two struck North Korea hard, causing serious infrastructure damage and destroying an estimated two thousand residences.  Kim Jong Un admitted that the storms will upend the country’s development plans for the year and is pressing on party members to help the country recover from the damage.  The country was struggling before the typhoons due to COVID-19 and sanctions.  These storms will increase its dependence on China.

 Tech policy:  Although there isn’t much chance it will be passed, three GOP senators have introduced legislation that would narrow the scope of Section 230 of the Communications Decency Act.  The proposed change would reduce the immunity that social media firms currently enjoy from the content appearing on their websites.  Although this effort will probably fail, we do expect that, at some point, the social media firms will have to choose between either accepting less immunity or being broken up.  It is difficult to reconcile the market concentration these firms enjoy with the protection they receive.  Meanwhile, across the pond, Facebook (FB, 273.72, +2.56) may no longer be able to send EU data back to the U.S. due to privacy concerns.

Economic and market news:  There are increasing reports of softness in the apartment market.  In New York, the COVID-19 exodus has led to a jump in apartment vacancies.  Some new apartment projects are offering two months of free rent to entice new tenants.  Reports indicate that renters are, for the most part, maintaining the rent payments.  As of September 6, 76.4% of renters made some form of payment.  The percentage is declining, but slowly.  We continue to monitor this data because it is looking less likely that Congress can come up with another round of stimulus.  Forecasters are lifting their expectations for Q3 GDP.  However, there are concerns (which we share) that the recovery will be very slow.  Finally, France says the U.S. is blocking talks on a global digital tax.  This is no surprise; the incidence of such a tax would fall heavily on American tech firms.  Although there are clear concerns about tech firms in the U.S. (see above), Washington has no real interest in having foreign governments implement taxes that would adversely affect U.S. companies.

 Odds and ends:  London bridge(s) is falling down.  Who knew?

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